The sales figures were the latest in a series of statistics providing Kenneth Clarke with the ammunition to resist Bank of England advice that the cost of borrowing should go up.
"The Chancellor is home and dry provided we do not see the pound weaken," said Leo Doyle, UK economist at Kleinwort Benson.
The pound, whose strength gave Mr Clarke the rationale for not raising base rates earlier this month, climbed further yesterday. Its index against a range of currencies gained 0.3 to 97.2.
Sterling also gained more than a pfennig to reach DM2.7142, within a few pfennigs of the rate from which it tumbled out of the exchange rate mechanism in 1992.
The FTSE 100 index closed nearly 24 points higher at 4,219.1, having retreated slightly from earlier highs after Wall Street opened.
Although City economists still disagree about whether interest rates should go up, there was near-unanimity yesterday that any move would be postponed until after the election. Only an extremely buoyant figure for GDP growth in the final quarter of 1996, due to be published on Monday, could tip the balance the other way.
December's retail sales performance helped the case against tougher monetary policy. The volume of sales fell 0.8 per cent during the month, although the estimated increase in November was revised to 0.9 per cent from 0.7 per cent.
Of last month's decline, 0.6 per cent was due to a sharp fall in sales of clothing and footwear following sharp increases in the previous two months. Sales in this sector remained the fastest-growing in the year to December, up 7.5 per cent, and discounts in the January sales could lead to a rebound.
Sales in "other" stores - mainly specialist shops such as chemists and jewellers - also fell and there was a small decline in non-store retail sales - mainly mail order - whose growth has been slowing for some months. There were increases in all other categories. These were strongest in department stores and supermarkets. The volume of sales at food stores increased by 0.4 per cent in December and 2.6 per cent year-on-year.
Tim Congdon, one of the Treasury's panel of "wise persons", said that one month's worth of weak data did not mean the case for tighter monetary policy had evaporated. "I would not put much weight on the figures around Christmas. The inflationary dangers remain," he said.
But others were more doubtful. "There is now enough of a question about the pace of growth for it not to matter waiting a month or two," said Michael Saunders, an economist at Salomon Brothers.
The next monthly meeting between the Chancellor and the Governor of the Bank of England will take place on 5 February.